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One of the biggest upsides to the downturn in housing has been a surge in demand for apartments.

Whether burned by foreclosure or afraid of losing money in homeownership, Americans have run in droves to rent. That resulted in a strong rise in rents and a big drop in vacancies over the past few years, as investors rushed to build more supply. Now, just as that supply is about to come on line, demand appears to be weakening.

Apartment vacancies fell by just ten basis points in the third quarter of 2012, from 4.7 percent to 4.6 percent, according to Reis Inc. While that is still an improvement, it is the slowest rate since the recovery began in 2010; vacancies fell by an average 35 basis points every quarter from 2010 and 2011.

"Demand for apartments still clearly outstrips supply growth, with absorption figures higher than construction, and vacancies declining. Still, there is cause for concern in the near-term that demand is abating for multifamily, just as a veritable avalanche of new projects begins to open their doors early next year," notes Reis economist Victor Calanog.

The change in occupied apartments also slowed to the lowest rate of absorption since the first part of 2010 and represented less than half the quarterly average of the past two years. This is particularly concerning, given how many new apartments are under construction and scheduled to open in the next two years. Multi-family housing starts were up 37 percent in August from a year ago, according to the U.S. Department of Commerce.

Reis estimates that accounting for delays and cancellations, between 160,000 and 200,000 new units will open in 2013. In 2014 that “total” figure (not adjusted for delays) exceeds 320,000. That is in the 79 markets it tracks, where only 41,000 or so units were built in 2011. The average annual figure from 2001 to 2008 was about 120,000.

Many analysts still believe apartment demand will remain robust in the near term, relative to where it has been historically, as so many potential home buyers are shut out of the mortgage market due to damaged credit. They also point to a shift in the homeownership mentality of younger Americans, who have seen what the housing crash did to their parents and who are gravitating more and more to urban centers.

"Renting an apartment offers extreme flexibility in today's techie generation and offers sociability," says Alexander Goldfarb of Sandler O'Neill. "It's huge how much kids want to be with other kids, and apartments lend themselves well to that. We are not seeing a sudden wave of people moving out to buy homes, even though housing is finding a floor."

In fact, Goldfarb says the move-out rate is now at 16 percent, below the historical average of 20 percent. The biggest issue for the big apartment REITs, like Equity Residential, Avalon Bay, Essex and Camden Property Trust, he adds, is slowing growth rates. The stocks themselves are down and underperforming because investors expected this to be the peak year for the sector.

"Does that continue or do other trends boost them?" asks Goldfarb. "When you look at absolute growth rates, it will look very good relative to other sectors, and that will bring investors back to apartments."

Goldfarb does not believe that the burgeoning single family rental market is taking share away from the multi-family sector, but others say it could play a role, especially for lower income families looking for more space. Investors in some of the hardest hit housing markets have been buying up as many distressed properties as they can find, citing new demand.

"I see unprecedented demand, more than I've ever seen in 15 years," says James McClelland, CEO of Chicago-based MACK Companies, a rental property investment group. "Our waiting list is already up to 4 months. if you pass our criteria to become one of our renters you get the honor of sitting on a four month waiting list until the next home is available to you."

The housing market may be recovering, but it is far from a robust recovery, and the lessons learned in the latest crash will likely keep rental demand high. Given where other commercial sectors are with vacancy rates, apartments are still the healthiest; it remains to be seen what all the new supply will do to the fundamentals over the long term. Analysts say 2014 is the year to watch.